1. Moving Forward: The Future of Insurance Industry Investments Accounting Firm Perspective Presented by: William J. Scannell, CPA Johnson, Lauder & Savidge, LLP NYIA Educational Seminar, February 12, 2009

2. Presentation Outline Accounting Issues Tax Issues Regulatory Changes Strategies Questions & Answers

3. Accounting for Stocks Carry on books at cost Adjust to market value at reporting date Adjustment is recorded as a change in surplus

4. Accounting for Bonds Carried on books at ‘amortized cost’ Premium or discount is written off over the life of the bond Presumption is the Company will hold to maturity

5. Asset Impairment For bonds: An impairment shall be considered to have occurred if it is probable that the reporting entity will be unable to collect all amounts due according to the contractual terms of a debt security in effect at the date of acquisition

6. Asset Impairment For stocks: A decline in the fair value of a stock that is determined to be ‘other than temporary’.

7. Impairment Determination Performed at the individual security level Indicating factors: –Length of time to which fair value has been less than cost –Financial condition and short-term prospects of the issuer –Intent and ability to retain investment for sufficient time to allow for recovery in value

8. Asset Impairment measurement Rules of Thumb developed to assist in evaluation of impairment: 1.20% below water 2.6 months below cost Identifying impairment is only the beginning of the analysis

9. Accounting for Impairment Write down cost to impaired value Loss become ‘recognized’ – reduces net income For stocks, moves surplus adjustment ‘above the line’ but no impact on surplus bonds, results in immediate reduction in surplus

10. Required Disclosures Each stock & bond in unrealized loss position for which other-than-temporary declines in values have not been recognized Aggregate loss Segregated by losses longer than 12 months and less than 12 months General categories of information considered

11. Deferred Taxes Assets and liabilities with different statement and tax values create deferred tax assets and/or deferred tax liabilities Deferred tax liabilities are always recognized Deferred tax assets, however, are subject to an admissiblity test

12. Deferred Taxes Impaired bonds and stock portfolios give rise to deferred tax assets Admissibility typically limited to the amount realizable in one year unless other deferred tax liabilities can offset –Typically can only be admitted to the extent there are realized capital gains in the current and two previous years

13. Deferred Tax Example #1 Unearned Premium Reserve - $5,000,000 –DTA = $340,000 ($5M x 20% @ 34%) –100% reverses in one year Unpaid Losses & LAE - $6,000,000 –Discount rate of 10% = $600,000 –DTA = $204,000 ($600K @ 34%) –$100,000 reverses in one year Unrealized capital GAIN - $2,000,000 –DTL = $680,000 ($2M @ 34%)

14. Deferred Tax Example #1 Deferred Tax Asset (Liability): Current Noncurrent UPR $ 340K $ 0 K Loss Reserve 100 104 Unrealized Loss (680) $ 440 $ (576) Net Deferred Tax Liability $ (136) K

15. Deferred Tax Example #2 Unearned Premium Reserve - $5,000,000 –DTA = $340,000 ($5M x 20% @ 34%) –100% reverses in one year Unpaid Losses & LAE - $6,000,000 –Discount rate of 10% = $600,000 –DTA = $204,000 ($600K @ 34%) –$100,000 reverses in one year Unrealized capital LOSS - $2,000,000 –DTL = $680,000 ($2M @ 34%)

16. Deferred Tax Example #1 Deferred Tax Asset (Liability): Current Noncurrent UPR $ 340K $ 0 K Loss Reserve 100 104 Unrealized Loss 680 $ 440 $ 784 Net Deferred Tax Asset = $ 1,224 K Net ADMITTED Tax Asset = $ 440K

17. Deferred Tax Example Comparison Total Admitted DTL - $ 2 M unrealized gain $ 136 K $ 136 K DTA - $ 2M unrealized loss 1,224 440 Effect on ledger 1,360 Effect on surplus 576 Additional surplus hit $ (784) K (20% of the unrealized loss for the year)

18. Tax Implications No deduction for unrealized losses Realized capital losses can only offset realized capital gains Remaining loss can be carried back 3 years, then carried forward 5 years – then is lost

19. Regulatory Changes for 2008 NAIC pending changes relaxing admissibility of deferred tax assets NYSID stress testing Disclosure of sub-prime mortgage disclosure –Regardless of materiality

20. Strategies Review portfolio for impaired assets –Develop a watch list –Involve investment & business advisors –Document procedure and conclusions Analyze deferred assets Consider sale of below market assets to recoup capital gain tax paid in 2006, 2007 and 2008 –Consider non-tax factors as well before selling

21. Questions ?

22. For further information contact: William J. Scannell, CPA Managing Partner Johnson, Lauder & Savidge, LLP (607) 723-8216 bill@jlscpa.com